Residential Security Solutions Provider Sector Alarm Holding AS Assigned Preliminary 'B' Rating; Stable Outlook

  • Norway-based Sector Alarm Holding AS (Sector Alarm) is the second-largest residential security solutions provider in Europe and has a resilient business model with high margins, but has relatively modest revenues (NOK2.3 billion or €230 million) and high geographic concentration.
  • Sector Alarm is raising a term loan to refinance existing debt and pay a distribution to shareholders, leading to a projected S&P Global Ratings-adjusted debt to EBITDA of 5.6x pro forma for the transaction at the end of 2019.
  • We are assigning our preliminary 'B' long-term issuer credit rating to Sector Alarm and our preliminary 'B' long-term issue-level and '3' recovery ratings to the group's proposed €590 million (NOK6 billion) term loan B and €100 million revolving credit facility.
  • The stable outlook reflects our expectation that the company will continue to invest in subscriber growth, resulting in strong annual revenue growth of around 7%-10% through 2020, with adjusted EBITDA margin in the low-40% range. We expect these investments will result in minimal, but positive, free cash flow and adjusted debt to EBITDA remaining above 5x through 2020.
  • The final ratings will depend on our receipt and satisfactory review of all final transaction documentation. Accordingly, the preliminary ratings should not be construed as evidence of final ratings. If S&P Global Ratings does not receive final documentation within a reasonable time frame, or if final documentation departs from materials reviewed, we reserve the right to withdraw or revise our ratings. Potential changes include, but are not limited to, use of loan proceeds, maturity, size and conditions of the loans, financial and other covenants, and ranking.
DUBLIN (S&P Global Ratings) May 24, 2019—S&P Global Ratings today took the above listed rating actions. The preliminary 'B' rating reflects Sector Alarm Holding AS' (Sector Alarm's) high debt leverage, with S&P Global Ratings-adjusted debt to EBITDA of around 5.6x expected at the end of 2019, pro forma for the announced refinancing and distribution to shareholders, its modest revenues, high geographic concentration, and exposure to technology risks. The preliminary rating is supported by the company's integrated business model, with low customer attrition and predominantly recurring revenues (95% of total revenues) resulting in predictable cash flows, and its proven ability to penetrate and scale existing and new European markets, which, given the low level of penetration in Europe, could drive strong growth in the future.
Founded in Norway in 1995, Sector Alarm has a long history providing professionally monitored security solutions in Europe, focusing primarily on residential alarms, and has proven it can penetrate and scale new European markets. However, with revenues of around NOK2.3 billion (€230 million), Sector Alarm has modest scale. In our view, scale is critical in the alarm monitoring industry given the cost of adding or replacing a customer and the typically high level of attrition. Despite double-digit growth in net subscribers, Sector Alarm is six times smaller than the European leader Verisure and closer to 20 times smaller than U.S. Prime Security, the global leader. Sector Alarm competes with Verisure in its two main markets, Norway and Sweden. While Sector Alarm is number two to Verisure in these markets, it has solid market positions, with 40% share in Norway and 35% share in Sweden. It is also the market leader in Ireland with 60% market share.
Despite its solid market positions, Sector Alarm has a high geographic concentration, with 93% of 2018 revenues generated in Norway, Sweden, and Ireland (established markets), although it has recently expanded to Finland, France, and Spain (growth markets). Additionally, its narrow scope and concentrated market position exposes the company to industry disruption, especially given the recent growth in the more innovative "smart home" space, particularly in the U.S. Also, Sector Alarm generates around 70% of its revenues through door-to-door sales distribution. While its competence in sales has contributed to strong growth, we think technology disruption (for instance, if customers adopt newer, digital go-to-market strategies or "do-it-yourself" installations) could have a negative impact on the company, although that has not been the case so far.
We view Sector Alarm's vertically integrated presence in the value chain positively. Its core offerings include sales, installation, monitoring, and customer services. We believe its deep level of involvement with its customers has contributed to among the lowest attrition rates in the industry of around 6% (on par with Verisure) compared to more narrowly focused U.S. alarm companies peers, which generally have attrition rates above 10%.
Sector Alarm's growth markets are significantly less penetrated than its established markets. Sector Alarm's growth markets have market penetration (defined as the percent of residential dwellings that utilize alarm monitoring services) in the 18%-27% range, compared to 8%-14% penetration in its growth markets. We believe Sector Alarm's track record of building market awareness in underpenetrated European countries through its commission-based, door-to-door sales strategy could lead to strong future growth.
We expect revenues to grow in the high-single-digit percent range over the next 12 months driven by 3%-5% revenue growth in its established markets and over 50% growth in its growth markets, which currently represent 7% of revenues. Adjusted EBITDA margins were around 43% of revenues in 2018. We expect EBITDA margins to decline as the company invests in sales in marketing to sustain growth in its maturing established markets, but to remain above 40% through 2020.
Our view of Sector Alarm's financial risk profile considers its high leverage, with S&P Global Ratings-adjusted debt to EBITDA of around 5.6x expected at the end of 2019, pro forma for the transaction. The company is majority owned and controlled by its founder, and we assume this will not change in the near term. However, we do not expect significant deleveraging following the transaction and we expect that the company will prioritize customer acquisitions, especially in its growth markets, over debt repayment. As a result, we believe adjusted debt to EBITDA will remain above 5x through 2020. We expect minimal free cash flow generation in the 12 months after transaction close. However, we recognize that a large portion of annual capital expenditures (over NOK600 million) relates to acquiring new customers, which we view as more discretionary than capital costs necessary for operations.
We rate several of Sector Alarm's peers in Europe and the U.S. We view Verisure (B/Stable/--) as the closest peer to Sector Alarm given its focus on Europe as the regional leader and its similar value proposition to its customers. Although both companies have comparable EBITDA margins, customer attrition, and track records of growth, we view Verisure's business profile more favorably given its much larger scale, its more geographically diversified revenue base, and its larger market share in the mature countries that both companies compete.
The stable outlook reflects our expectation that the company will continue to invest in subscriber growth resulting in strong annual revenue growth of around 7%-10% through 2020, with adjusted EBITDA margin in the low-40% range. We expect these investments will result in minimal, but positive, free cash flow and adjusted debt to EBITDA remaining above 5x through 2020.
We could raise the rating if continued growth in EBITDA reduces adjusted debt to EBITDA to less than 5x, supported by a more conservative financial policy. An upgrade would require revenue and EBITDA to at least remain stable.
We could lower the rating if technological disruption, operational missteps, or other factors result in declining EBITDA and negative free cash flow, or if the company adopts a more aggressive financial policy such that adjusted debt to EBITDA increases to above 7x.
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